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Is it time for 401k savers to abandon bond mutual funds?

Many investors hit the "sell" button on bonds in June -- but if your focus is on retirement, think through your options before you follow the crowd.

The specter of rising interest rates spooked investors into pulling an estimated $60.5 billion out of bond mutual funds last month -- almost a 47% jump from the $41.3 billion withdrawn in October 2008, amid the worst moments of the financial crisis -- according to preliminary data from the Investment Company Institute, a mutual-fund trade group and researcher.

Yields on 10-year Treasurys jumped as high as 2.6% in June, from 1.6% in early May, thanks in part to Federal Reserve Chairman Ben Bernanke's hints about the end of the central bank's bond-buying program, which has pushed interest rates to record lows in recent years. (Bond prices move inversely to yields.)

Some of the biggest bond funds in the 401(k) universe took hits. Pimco'sTotal Return fund (PTTAX) plunged more than 5% from May 1 through July 1 (it's down more than 3% year to date). That fund holds a whopping $79.9 billion worth of 401k assets, according to December 2011 data, the most current available, from researcher BrightScope.

Another big 401k player, Vanguard's Total Bond Market Index fund (VBMFX), dropped about 4% in May and June, and is down more than 2% so far this year. It's enough to make your average 401(k) investor break out in cold sweats.

Here's your first rule: Don't panic. Generally, the best advice for people investing for the long haul -- and your retirement could well last 30 years -- is to pick a suitable asset-allocation strategy, invest in low-cost mutual funds, rebalance regularly and stick with your plan to guard against the all-too-common mistake of buying high and selling low.

Still, following that prudent strategy doesn't mean you should ignore big-picture trends. Rates have been at extraordinary lows since the 2008 crisis. They really have nowhere to go but up, forcing bond values down.

With individual bonds, investors can hold them until their maturity date to retrieve their principal. But most 401k participants have access only to bond mutual funds. As investors flee for the exits, managers may be forced to sell bonds before maturity to honor those redemptions.

Yet, despite the current rate outlook, it doesn't make sense to exit bonds entirely, experts say. One reason: While interest rates are bound to rise, no one knows when. And it could well be a year or more before the Fed makes a move.

"You're essentially timing the bond market just like people try to time the stock market and you've got the same risk: You could be wrong," says Thomas Batterman, a principal at Financial Fiduciaries in Wausau, Wis.

And don't forget why you own bonds: They provide a ballast against stock-market gyrations. "Although one component might come under pressure, it's the other part of the portfolio that you hope is acting as a buffer. That's the beauty of a balanced portfolio," says Catherine Gordon, a principal with the investment strategy group at Vanguard Group.

That said, here are steps 401k investors might consider as they eye the bond-market upheaval:

1. Shift to shorter-term bonds

Generally, long-dated bonds suffer the most as interest rates rise.

A good approximation of risk is that for every percentage point increase in interest rates, your bond fund's value will drop as much as its overall duration ("duration," roughly speaking, is the average maturity of the fund's bond holdings).

If a fund's duration is five years and yields increase two percentage points, the value of the fund will go down by about 10%.

2. Review your target allocation

"For so many years, for so many people, the formula has been 60% equities, 40% bonds," says Bill Harris, chief executive of Personal Capital, an online wealth-management company in Redwood City, Calif. "That's probably not appropriate today."

"It's a very dangerous time to be heavily in long-term bonds," he adds. "We don't think you should be void of long-term bonds and we certainly don't think you should be void of bonds, but shorter durations, lower exposure to bonds than would traditionally be the case."